Cash Balance Pension Plans and Claims of Age Discrimination

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Both Hurlic and Selesky were eligible for the grandfather provision and elected to continue accruing benefits under the pre-conversion formula until it expired in June Therefore, Hurlic and Selesky would not accrue any additional benefits during these respective periods of time. After a number of dismissals from the trial court for failure to state a claim on all counts, Hurlic and Selesky appealed to the Court of Appeals.

First, the court said the ERISA provides for two types of pension plans, defined contribution plans and defined benefit plans.

Cash balance plan

Cash balance plans are defined benefit plans. The pool of assets can be funded by the employer, employee, or both. There are three anti-backloading provisions of ERISA, and plans need to only comply with one of them. SCGC admits adequate notice was not provided, but argues Hurlic and Selesky did not sufficiently allege they suffered harm. The complaint alleges that Hurlic and Selesky were deprived of the opportunity to file for injunctive relief, and the pursuit of alternative retirement strategies.

As part of the Eaton case the IRS District Director for the Cincinnati office has also questioned whether cash balance formulas "satisfy the clear and straightforward requirement" against reductions in rates of accrual because the formula's "benefit accrual rate decreases as a participant attains each additional year of age.

In September , the IRS required determination letters for cash balance plans to be referred to and handled by the National Office - which the IRS characterizes as a "delay" but not a "freeze" on these approvals. For example, participants can argue that creation of the "wearaway" was age discriminatory - or at least provides evidence of age discrimination - because older workers are more likely to be adversely affected by the wearaway.

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Under ERISA an argument can be made the plan fiduciary has a duty to inform employees of this "wearaway" - which is discussed in the following fiduciary section of this article. Fortunately, ERISA requires accruals to be judged based on the amended plan - which should mean judged based on changes to the hypothetical account balance that continues to increase during the "wearaway" period.

Fiduciary issues regarding setting the opening account balance were raised in the Corcoran v. The claim "wearaways" are discriminatory is being presented in the Engers v. These studies typically analyze how benefits would be paid out under different formulas based on, e. If the plan is a conversion from a "final average pay" plan, these studies often show substantial decreases in benefit accruals for long term employees as compared to the "final average pay" jump. An argument can be made and is being made in the Eaton v. Onan Corp. Although no court had yet directly ruled on this issue in the cash balance context, such a claim would have at least three substantial hurdles to cross.

Nor does ERISA mandate what kind of benefits employers must provide if they choose to have such a plan. Plan sponsors who alter the terms of a plan do not fall into the category of fiduciaries. When employers undertake those actions, they do not act as fiduciaries, but are analogous to the settlors of a trust. This means any comparison between the benefits provided under the new cash balance plan with those that could have been earned under the old plan would be based on the false legal premise that there was some entitlement to those now-ex future benefits.

Thus, if courts apply these two principles to cash balance plan design, a plaintiff should not be able to show such design was age discrimination simply because the employer knew its design would have an adverse impact on older employees; rather, a plaintiff would need to show the employer adopted the design with the intent to have that effect, i.

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In most cases this should not be possible, as employers are adopting plan designs based on numerous "factors other than age," e. Third, is the point detailed in the Lyons case discussed above that younger employees typically accrue more benefits because of the unexceptional proposition that they are in the pension plan for a longer period of time, not because of age. On a related point, at least for plans designed without "wearaways," those plans should be able to establish the "equal cost" defense. Under ADEA, discrimination based on age regarding an employee's "terms, conditions, or privileges of employment" is nonetheless lawful if the employer establishes for its benefit plan that "where for each benefit.

Moreover, the Seventh Circuit in Quinones has noted that a younger employee's ability to grow an account balance for a longer period does not affect this defense because the amount contributed is the same for each: An employee who works under a defined-contribution plan between the ages of 25 and 45 will have more in the account at age 65 and receive a higher annual pension than an employee who works between the ages of 45 and Because this difference does not violate the ADEA recall that the employer contributes to the account an identical percentage of salary for both workers it would make no sense to say that an equivalent adjustment to a defined-benefit plan violates the Act.

And the EEOC's [equal cost] regulation has reached this conclusion.

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  6. Plaintiffs often argue because these loss of future accruals adversely affect older workers they must have been designed to get rid of these older workers - thus, this plan change in itself suggests discrimination. In other words, it makes no sense to infer discrimination when companies have cheaper - and lawful - ways to accomplish the purported prohibited goal. An "intent" claim would likely, as discussed above, run into proof that the cash balance plan was likely adopted for numerous "reasonable factors other than age" such as to lower costs, to provide a better understood benefit, or to better match a mobile workforce.

    Such a claim may also be legally categorized as a "disparate impact" claim. As detailed below, this claim would likewise be subject to substantial hurdles. A "disparate impact" claim is premised on proof that a facially neutral policy or practice that has a significant adverse impact based on the prohibited characteristic may be unlawful simply because of that adverse impact, even without proof of any discriminatory intent.

    This freeze or termination would have a far larger disparate impact than a plan conversion and yet, unless ERISA and the Supreme Court's statements were to be robbed of meaning, would thus not be subject to challenge on a disparate impact theory. This means that any disparate impact challenge even if allowed would have to be limited to analysis of the benefits provided by the new cash balance plan. Because these plans are typically age neutral and adopted for substantial business reasons, there is usually no adverse impact.

    Stated another way, a plaintiff should not be able to make out a disparate impact claim by comparing an age-favored plan to an age-neutral plan because there is no legal or policy entitlement to continuation of that age-favored plan. This leads to "wearaways" if the opening hypothetical account balance is set below this amount. The most significant "accrued benefit" issue, however, involves the payment of the hypothetical account balance as a lump sum at termination. Cash balance plans are typically designed to pay this benefit at termination and this balance is also what is communicated to the employees as their "benefit.

    Some cash balance plans have provided for interest rate credits greater than the GATT rate, which can result in the value of the discounted present value of that accrued benefit being greater than the hypothetical account balance at termination. Put simply, the hypothetical account balance grows at a higher rate than the rate at which it is being discounted. The following table and graph illustrate this "whipsaw" principle assuming only a.

    Not surprisingly, this "whipsaw" issue has been raised in three of the five cases litigated to date, i. In the Edsen case discussed in detail below, the district court approved use of a two-tier interest credit structure i. If the foregoing is followed, the IRS assumes that the approved rates do not exceed the GATT rates and deems that a plan has made a "reasonable good faith" interpretation of applicable law.

    The one case to date to consider Notice , Edsen v. Although no court has ruled on this issue yet, it appears highly likely that a court would defer to this IRS guidance in upholding a plan that followed the Notice "safe harbor" approach.

    Litigation Issues In Cash Balance Plans

    Fiduciary and Notice Issues 1. The first requires the fiduciary to provide "complete and accurate information" upon request: The trustee is under a duty to the beneficiary to give him upon his request at reasonable times complete and accurate information as to the nature and amount of the trust property. Courts have varied on how stringent, if any, of a "duty to inform" of "material information" they will impose.

    Communicating Differences in Benefits and "Wearaways" As noted earlier, one of the major criticisms leveled against cash balance plans is that they adversely affect older workers. The other major criticism is that employees are not told how their benefits are affected by a conversion to a cash balance plan, e.

    Under a fiduciary duty claim, "wearaways" and comparisons of benefits raise different issues. The duty to communicate "wearaways" is the stronger argument. The disclosure claim will be strengthened if, during the "wearaway" period, the employer provides the employee annual or projected benefit statements showing increases in the hypothetical account balance without disclosing the accrued benefit. The employee can argue this was a misrepresentation by asserting a "reasonable employee" would assume that this increase in account balance was an increase in pension benefits.

    If the court agrees, it will be far more likely to find a fiduciary breach. The same type of arguments can be made for general comparisons of benefits earned under the cash balance plan as opposed to what may have been earned had the old plan been kept in existence. This presumption is false under ERISA, as an employer has the right at any time to freeze or terminate accruals. Thus, the projection if shown would be zero. An argument can still be made that an employer would need to show what "would have happened" had the old plan stayed in effect, but it is a weak one given these facts. Logically, it is no different than projecting what "would have happened" had the employer turned into Santa Claus and dedicated all profits to employees' pensions. If there is doubt, the employer should nonetheless consider sending this notice, as the remedy for failure to comply with this notice requirement is draconian: The amendment is not effective and participants continue to accrue benefits at the pre-amended rates unless and until proper notice is sent.

    Thus, an employer is a "settlor," not a fiduciary, when designing and adopting a cash balance plan. Most plaintiffs will, however, be asserting in their complaint or in response to a motion to dismiss a claim for benefits and most courts will allow this asserted claim to suffice to provide standing. Courts are split on whether exhaustion is required when the claim for benefits is premised on alleged statutory violations instead of the plan terms.

    No private right of action - When challenging cash balance plans, plaintiffs often plead highly technical claims that rely on IRS regulations and guidance. Accordingly, any claims based on these non-parallel provisions and attendant regulations are subject to dismissal because the IRC, in itself, does not provide for a private right of action. When the plaintiff is seeking a benefit not provided by the terms of the plan, the "equitable remedy" available is unclear: Depending on the nature of the claim, some courts construe their equitable powers broadly to order, e.

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    Litigation To Date A. The Aull v. In Aull, the pension plan offered the employees the greater of the benefit provided by two pension formulas: a traditional "career average pay" formula and a "cash balance" formula. The plan was frozen effective June The parties disagreed over how the plan addressed what to do with the hypothetical account balance when an employee had no more benefit service i. The plan practice from to was to use the PBGC rate of 7. In the plan went to floating matching rates to project forward and to discount - i.

    In the litigation, a major claim was that the cash balance rate of accrual decreased on account of age in violation of ERISA - i. The cash balance issues in Aull were pursued principally before the IRS in a determination letter request and an audit. Plaintiff in the form of "interested party" comments to the IRS asserted, e. A settlement was reached with the IRS that has become part of the global settlement of this case. The Edsen v. Bank of Boston Case The Edsen case dealt with the "whipsaw" issue in projecting a hypothetical account balance to and from normal retirement age.

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    The plan also provided for a two-tiered interest credits: While employed, the employee would receive the 3 month Treasury bill rate plus. However, to require the Plan to use an interest rate of 5. The Plan was introduced to allow plan participants to know the dollar value of their accrued benefits at any given point in time before retirement and to allow younger employees an opportunity to accrue more benefits earlier in their careers.

    As explained by the Internal Revenue Service in Notice , "most cash balance plans are designed to permit a distribution of an employee's entire accrued benefit, after termination of employment, in the form of a single sum equal to the employee's hypothetical account balance as of the date of distribution. These provisions "mimic the benefit and accrual structure" of a more traditional annuity plan.

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    IRS Notice Interestingly, Notice itself suggests that use of a two-tiered interest rate structure may constitute a forfeiture. In one section the Notice states interest credits are "in the nature" of "accrued benefits" protected from forfeiture: Under a cash balance plan, the retirement benefits payable at normal retirement age are determined by reference to the hypothetical account balance as of normal retirement age, including benefits attributable to interest credits to that age.

    Thus, benefits attributable to interest credits must be taken into account in determining whether the accrual of the retirement benefits under a cash balance plan satisfies one of the rules in section b 1 A , B , or C. If such a plan provided that the rate used for projecting the amount of future interest credits was no greater than the interest rates used under section e 3 , the projection would result in a forfeiture.

    The Corcoran v.